Islamic finance 'must focus on regulations'
Manama, June 15, 2010
To continue to grow, Islamic finance needs to examine its foundations and ensure they are strong enough to support the massive growth the industry has seen in recent years.
That was the message from Central Bank of Bahrain Governor Rasheed Al Maraj to delegates at the first Annual World Islamic Banking Conference Asia Summit in Singapore yesterday.
In a keynote address, he said that three issues the industry had to address were concerns about achieving certainty in contracts, the need to enhance the industry's ability to manage risk and the development of a regulatory framework to keep pace with the rapid growth of the industry.
'It is a fact that we are still some way from developing standard documentation which is recognised as Sharia-compliant by scholars from different jurisdictions and from different schools of Islamic jurisprudence,' he said.
'As long as there is a risk that a contract which is recognised as Sharia-compliant by some scholars will not be recognised as such by others, there exists a lack of legal certainty in the industry.
'The result has been that Islamic financial institutions have had a predominantly domestic focus and have not been able to achieve the scale economies that might make them viable competitors to conventional institutions which do enjoy these benefits,' he said.
'Since the global financial crisis began, we have seen the first defaults on sukuk,' he added.
'These defaults have raised a number of difficult legal questions which are currently before the courts.
'The conventional financial industry received a wake-up call during the crisis concerning the importance of understanding, monitoring and controlling liquidity risks. The Islamic financial industry must recognise that it too needs good liquidity risk management.
'How Islamic financial institutions can manage their liquidity risk given the relative absence of short-term money market instruments has been a problem for the industry for some time,' he added.
He said the industry had to limit the concentration of risk in particular economic sectors or asset types.
'The industry's preference for a real asset to back financial transactions has, unfortunately, resulted in a relatively high concentration of risk in real estate,' he said.
'As a result, many Islamic financial institutions have asset portfolios which are concentrated on this potentially very volatile sector.'
Although the Islamic financial industry was relatively insulated from the first round effects of the crisis because it did not invest in toxic structured financial products, it has not been able to avoid the second round effects, he said.
'These have included sharply reduced liquidity in all markets, and the effect of the global economic downturn on the credit-worthiness of all borrowers, including those who are customers of Islamic financial institutions,' he added.
'The principles of sound finance - do not concentrate risk, do not rely on collateral with unrealistic valuations - apply equally to Islamic institutions as to conventional ones.
'As the international standard setting bodies develop new prudential standards that reflect the lessons of the crisis we need to be ready to revise the prudential framework for Islamic financial institutions accordingly.
'We will need to adapt the new capital adequacy and liquidity standards for conventional institutions to reflect the specific circumstances of the Islamic financial industry.
'Even so, I strongly believe that if we can ensure that the foundations are sufficiently robust, the Islamic financial industry has a great and profitable future ahead of it,' he said.-TradeArabia News Service